Altria eyes UST, but price in question -- sources

Brad Dorfman and Jessica Hall

CHICAGO/PHILADELPHIA, Feb 1 (Reuters) - A long anticipated deal by Altria Group Inc MO.N to buy smokeless tobacco company UST Inc UST.N could be reached within months, but the price remains the toughest sticking point, sources familiar with the potential deal said on Friday.

UST shares closed 5.8 percent higher on Friday amid market speculation a deal was looming, analysts and investors said. Altria stock shed 0.5 percent.

UST and Altria declined to comment.

Altria, which last year spun off Kraft Foods Inc KFT.N and plans to spinoff its Philip Morris International unit on March 28, has been seen for years as poised to make an acquisition in the smokeless tobacco market.

“The writing is on the wall, and has been on the wall for years, that this was the inevitable combination,” said one consumer investment banker, who declined to be named.

“Altria has made no secret of its intentions for the smokeless market. But Altria had a lot of steps to make before they could make a move. Of course, in that time, UST’s prize smokeless business has deteriorated some,” the banker said.

UST recently posted a 1.4 percent rise in fourth-quarter profits, but suffered a decline in market share for its core smokeless tobacco business.

UST, which makes Skoal and Copenhagen tobaccos, is facing increasing competition from Reynolds American Inc RAI.N and Altria's Philip Morris USA unit.

Reynolds bought the Conwood smokeless tobacco business in 2006 and Philip Morris has been test-marketing a smokeless tobacco under the Marlboro brand. Buying UST, however, would give Altria an instant boost in that market to help diversify its revenue, analysts said.

“What’s the quickest way to build share in smokeless tobacco? Just buy UST,” said Morningstar analyst Gregg Warren.

Uncertainty remains, however, about how much of a premium UST’s brands such as Copenhagen and Skoal can command over lower-priced competitors in the long-term, he said,

UST has been spending money on promotions to try to keep its customers from defecting to lower-priced brands by lessening the price gap between its products and competitor’s brands in specific markets without actually cutting the list price.

UST, which has a market capitalization of $8.1 billion, would be a small acquisition for Altria, which boasts a market capitalization of $159.6 billion.

Fueling speculation Altria could be readying for a deal was the decision to announce only $20.5 billion worth of share buybacks, combined, by Altria and Philip Morris International. Analysts had said the the company had the balance sheet for much greater buybacks if management chose.

Altria Chief Executive Louis Camilleri said on Wednesday the amount of the repurchases was reached to leave the companies with financial flexibility.

“I think it’s very important and history has taught us that we should have flexibility and financial wherewithal to be able to respond to opportunities,” Camilleri said.

Previously, Camilleri has said that much of Altria’s U.S. growth will come from an “adjacency strategy,” where the company focuses on non-cigarette products, like smokeless tobacco.

In addition to the spike in UST’s stock price, options trading also surged on Friday.

“After seeing share price declines and put buying for much of this week in UST on grounds that Altria is making more aggressive moves in the American chewing tobacco market, today we observed a 10 percent spike in UST’s implied volatility,” said Rebecca Engmann Darst, an equity options analyst at Interactive Brokers Group.

The “gain in UST’s share price and call buying on Friday at strikes at $55 and $60 in February and March tell us that traders are looking for further gain in share prices,” Darst added.

UST shares closed at $55, up $3.04 on the New York Stock Exchange. Altria shares closed at $75.44, down 38 cents, on the NYSE. (Additional reporting by Doris Frankel in Chicago; Editing by Andre Grenon) (For more M&A news and our DealZone blog, go to here)